According to Goldman Sachs, middlemen have become monopoly buyers of agricultural produce, allowing them to take advantage of any shortage in supply, or spurt in demand, but they will not pass on the benefits to farmers or consumers

The Indian economy is grappling with inflation, with the Reserve Bank of India trying to curb the problem through continuous monetary tightening. In the quarter to June, inflation has remained at an elevated level, resulting in a 75 basis points (bps) hike in the repo and reverse repo rates.

Food inflation continues to remain a key worry and a check on the food supply chain reveals structural problems that are unlikely to go away in the near term.

But, according to Goldman Sachs, rising food prices are benefitting middlemen rather than farmers and also preventing a supply response. "One of the biggest constraints to the proper functioning of agricultural markets is the Agriculture Produce Marketing Committee (APMC) Act, which prevents farmers from selling their produce directly to retailers or the consumer. They can only sell in government-mandated markets (mandis) to licensed middlemen," Tushar Poddar, chief economist, India, Goldman Sachs, wrote in a report. "Being monopoly buyers allows the middlemen to take advantage of any shortages in supply, or spurts in demand, without passing on the benefits to farmers and generating the adequate supply response."

Food inflation is widespread, and is the cause of strong demand and deep structural factors. A team from Goldman Sachs visited one of the biggest retailers of vegetables in Ahmedabad. Quoting the store manager, the investment banking and research firm said vegetable prices have doubled since the start of the year. In the store, tomato prices were up to Rs20 a kg from Rs8 a kg at the start of the year; onion prices were at Rs11.50 a kg from Rs6 per kg, lady-finger prices have gone to Rs50 a kg from Rs25. There has been a bit of a volume response where substitutes are readily available, as sales have gone down to 2,500 kg daily, from 3,000 kg of fruits and vegetables at the start of the year, it said.

"Our meetings suggested that most of the price rise is not benefitting farmers but middlemen. One of the largest players in the apple trade mapped out the supply chain for apples from farm to fork which suggests a 50% price appreciation from the farmer to the end-consumer. In several cases, it is even higher," the report said.



According to a study by CRISIL, during 2008-09 to 2010-11, food inflation was at 11.6% as compared to non-food inflation of 5.7%. Among 316 goods that have clocked a sharp increase in prices, 36 are raw food articles and 14 are fuel items. Prices of aviation turbine fuel (ATF), kerosene, bulk of fruits and vegetables have all witnessed double-digit inflation. Inflation in eggs, meat and fish averaged at 23.6% in 2010-11, while inflation in milk stood at 19.7%. Milk prices have nearly trebled during the last two years.

As disposable incomes rise, consumer preferences have been shifting towards 'protein-based' food items such as eggs, meat, fish and milk from traditional food items like food grains and cereals, thereby pushing up prices of the former category, the ratings agency said. (Read more, "Higher inflation cost households Rs5.8 trillion over last three years".)

Goldman Sachs said, although demand has remained strong due to rising incomes which allows the middle-men to raise prices, there are some structural factors contributing to food inflation dynamics. The report said the unorganised nature of the distribution chain makes for multiple layers of inefficiency and rent seeking. At each stage, there is some loss of produce due to multiple hands the product goes through and inadequate infrastructure.

The lack of large and organised contract farming, and foreign direct investment (FDI) in retail, along with the prohibition of farmers selling to retailers directly, has prevented the establishment of seamless supply chains, competition, and economies of scale that are so critical for increasing productivity, the report said.

Talking about the erosion of agricultural land around the cities, due to rising real estate demand, Goldman Sachs said that with cities expanding rapidly outwards, the agricultural areas around the city-where the high value-added fruits, vegetables, milk, poultry are grown-have suffered, as farmers have been selling land to benefit from higher real estate prices. This has had a chain effect on land prices, resulting in less land for high value-added products. Therefore, the supply response to rising prices has been slow in coming.

Indeed, prices of fruits and vegetable are up 17%, milk 18%, and eggs, meat, and fish by 23% in the last 12 months. However, the investment in storage, cold chains, and transportation has been patchy, therefore wastage remains high, which is likely to keep the price level high, Goldman Sachs explained.

The investment bank said, in India, the employment guarantee scheme has led to increase in labour payment and had affected labour supply as well. It said, "The National Rural Employment Guarantee Act (NREGA) has led to increased wages and reduced agricultural and general labor supply."

In order to create a competitive market, especially in fruits and vegetables, India could take the import route. However, due to high tariff barriers on agricultural imports, this has not happened and consumers have to be dependent on domestic supply. "India imposes a tariff ranging from 30%-50% on imported fruits and vegetables, which prevents import competition," Goldman Sachs said.

"Our visit suggests that food prices may remain elevated," the report concluded. "Indeed with the rise in diesel prices, transportation costs will be higher, since most of the produce is transported by diesel-run trucks."